The company Smart Inc. is a company that produces T-shirts inToronto area. The results of the company which has been mediocrefor the past couple of years have been presented in the annualfinancial statement.

Sales (1 million units x 16$) 16 000 000$

Fixed Costs (10 000 000)

Variable Costs (1 million units x 10$) (10 000 000)

Depreciation (3 000 000)

Annual Profit (loss) (7 000 000)

According to the experts, this loss has been caused by the poorperformance of the equipment in the factory. They suggest to theboard of directors to replace the old equipment by new ones.Considering following information, the board of directors asks youto evaluate this project for the company.

• The new equipments would increase the level of production andallow the company to avoid this loss entirely, but there is noprojection concerning any profit. The purchase (including theinstallation) of the new equipment requires an initial investmentfor an amount of 18 000 000$. The old equipment can be sold in thebeginning of project on the market for 1 500 000$ (Forsimplification, consider this amount as an exchange value).

• The new equipment will be sold for 2 000 000$ in 10 years (endof project). The purchase of the equipment requires a new issue oflong term bonds with a coupon rate of 8% over 10 years. The projectalso requires major renovation of the old building for the amountof 500 000$ and an additional investment in heavy machinery for thetotal amount of 1 000 000$ at the end of 5^th year (Bothamounts are depreciable with declining method under the taxlaw).
• The project requires the purchase of a land for 1 200 000$which will be sold in 10 years (end of project) for 2 200 000$.Suppose that at this moment 50% of capital gains are tax-free undertax law.

• The company also has to build a new building for an amount of 2400 000$ which will be sold at the end of the project for 3 200000$. This amount is depreciable with declining method.

• The project also requires an additional investment in newComputers and furniture for a total amount of 400 000$ in thebeginning of project. Computers and furniture have to be replacedby new ones after 5 years for the amount of 600 000$. The do nothave any salvage value.

• At the present time, supplier account and client account are at1 000 000$ each. The project would increase client account anddecrease supplier account by 50%. All related accounts will returnto zero at the end of project.

• At the present time, Smart Inc is renting a warehouse for theannual rent of 50 000$ (paid at the end of year). If the companyundertakes the new project, they will need to cancel the lease ofthe old warehouse and to rent a larger warehouse for the annualrent of 200 000$ (to be paid annually at the end of each year). Thecancellation of the old lease does not cause any penalty.

• The project also requires 5 new technicians today with annualsalary of 60 000$ for each and 5 other technicians in 5 years forannual salary of 75 000$ each. Given the performance of newequipment, Smart Inc could lay off 80 employees whose annualsalaries is 40 000$. The lay-offs will oblige the company to paylay-off premiums in the amount of 10 000$ to each employee whichwill be tax deductible.

The corporate tax rate is at 40%. The new equipment and newheavy machinery are in the category with a depreciation of 20%, themajor renovations are depreciated at 25%, the new building isdepreciated at 10%, all items depreciations are calculated withdecreasing (declining) method. The computers and furniture aredepreciated by linear method at 20%. Investors require 12% returnon this type of project. Given this information, answer thefollowing questions:

Questions:

1. Identify ONE BY ONE each item of the investment and calculateseparately the present value of the total investment in thisproject.
2. Identify ONE BY ONE and calculate separately the present valueof each periodical cash flow (annual incomes and expenses) duringthe project.
3. Identify ONE BY ONE and calculate separately the present valueof each cash flow of the end of the project.
4. Calculate the Net Present Value of this project (You just haveto add up your responses in 1, 2 and 3 for this one).
5. Calculate the maximum price that Smart Inc can afford to investin the new equipment in the beginning of project in order to keepthe project profitable. (That means the additional investment atthe end of 5^th year and other items in the initialinvestment remain the same).
6. Calculate the Operational Cash Flow (OCF) of the 3^rdyear of this project.